This downturn may be taking place in a different environment, but China still acted. Will other governments?

Now that China has put out a large domestic spending plan that amounts to USD586 billion, other governments world-wide strongly affected by the crisis might have to take similar steps, especially given faltering consumer spending and investments. But since the world is different from the past, such as improved technology, greater interconnectivity and higher mobility of workforce, would the downturn play out differently? What’s the resulting impact on developing countries?

With consumers being engines of the economy, their general lack of access to credit, fear of job losses and the resulting belt-tightening are causing a sharp downturn in spending. As such, on the investment component of the GDP, there is a lack of will for businesses to invest; home values, still at elevated levels, have to come down, causing investments to continue to suffer. In the US, the rising dollar does not help with the trade balance, also hurting the export industry, aside from the credit issues. We might be entering a deflationary environment, with input (eg, fuel, commodities) prices falling and firms cutting prices to clear inventory. A deflationary spiral would be a bad outcome.

But this downturn takes place under a different environment, with improved technology and greater mobility of workforce, than previous ones, so could the situation be different?

(1) Would improved technology help? It will, but more in the long run as technology looks to be correlated with increasing productivity. (Hence, economies still have to recover first. However, ways that increases aggregate demand in the short that also helps increase productivity in the long run would be most appropriate. Infrastructure projects are therefore usually taken.) What about the web or the higher interconnectivity around the world? It is hard to say outright. Nonetheless, fundamentally, the web is a platform that consumers and producers transact, rather than doing it on the street, so the basic economic interaction between consumers and producers remain the same. Thus, if demand falters, so does production. Moreover, if the wealth generated by the web is not “tangible,” but people treat it as if it were tangible, then the bursting of the asset bubble could be worse then, as the true value is realized. This happened after the bursting of the technology bubble earlier.

(2) The mobility of the global workforce has also improved significantly in recent years, but it is the very mobility of workforce that will make the situation in many OECD countries worse. As wages in those countries are still high, then moving operations to low wage countries will continue. In the last couple of years when the economy was booming, some companies have slowed or reversed the pace or direction of outsourcing, due partly to customer-service issues and time-zone differences. This reversal to some extent cuts into corporate profit but was more than offset by gains during the boom. But with profits shrinking during the recession, firms would likely to take greater advantage of this labor arbitrage and began another wave of outsourcing/offshoring, now perhaps on more core operations that do not have to be in high-wage countries.

At first glance, developing economies might appear to benefit from it. Nevertheless, I’d think that the benefits are likely to be offset by losses in other areas. As exports still account for a large portion of their economies, internal demand looks unlikely to bridge the gap left by falling exports. In fact, many who work in the exports industries will or are afraid that they would lose their jobs, which dampens the propensity to spend. In fact, this is happening in China as well, as domestic consumption falls measurably in Q3. China is also working off its own real estates bubble.

The role of government could be key. Since self-interests prompt people to hoard cash and not spend, then the hope for a recovery from either consumers or businesses could prove elusive. Given the severity of the downturn, then a coordinated effort is needed to boost the economy, so the government, which is the single biggest entity in the economy, would need to take the lead.
China has taken that step, with the massive government spending program. Will others do the same? Or will they have the means to do the same?